PUBLIC FINANCE

Importance of Public Finance

WEEK 3
Module 3 Importance of Public Finance
At the end of this module, you are expected to:
1. Explain the Importance of Public Finance
2. Discuss the categories of public goods

IMPORTANCE OF PUBLIC FINANCE

1)Arrangement of public goods: -For providing public goods like roads, military services and
street lights etc. public finance is mandatory. Business firms will don't have any motivation to
achieve such goods, as they get no payment from private individuals.

2)Public finance enables governments to engage with or offset undesirable side effects of a
market economy. The side effects are called scatter over or externalities. For instance, pollution.
The governments can propose recycling programmes to diminish pollution or they will make
laws to limit pollution or impose pollution charges or taxes on activities that originate pollution.

3)Public finance helps governments to redistribute income. To cut back within the inequality in
the economy, the governments can impose taxes on the richer people and supply goods and
services for the needy ones.

4) Public finance provides many an programmed for moderating the incomes of the rich and also
the poor. Such programmed include social security, welfare and other social programmed.

5) The approval of the principle of welfare state, the role of public finance has been increasing.
Current governments aren't more police states because the classical economists considered.

6) As the outlook of state participation within the financial activity is expanding, the scope of
public finance has also been rising. Bearing of employment opportunities, control of economic
fluctuations like boom and depression, maintaining economic stability etc. are any of the thrust
areas of the governments through fiscal operations.

THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE

The particular of the crucial principles of public finance is that the so – called Principle of
Maximum Social Advantage interpreted by Professor Hugh Dalton. Related to a people pursue
to escalate his satisfaction or welfare by the use of his resources, the state must to broaden social
advantage or get comfort from the resources at its command.
The principles of maximum social advantage are applied to decisive even if the tax or the
consumption has tested to be of the optimum benefit. Hence, the principle is termed the principle
of public finance. According to Dalton, “This (Principle)mislead at the very root of public
finance” He again says “The surpass system of public finance is that which secures the ultimate
social advantage from the operations which it handling.” It should also called the principle of
maximum social benefit. A.C. Pigou has termed it the principle of maximum aggregate welfare.

Public expenditure builds service for those people on whom the amount is spent. When the
volume of expenditure is little with a affront increase in it, the further utility is incredibly high.
Because the entire public expenditure force on rising in course of time, the law of diminishing
marginal utility conducts. People derive less of fulfillment from extra unit of public consumption
because the administration spends more and more. That is, after a stage, every increase in public
expenditure build less and less benefit for the individual. Taxation, on the opposite hand, appoint
burden on the individual.

So, when the volume of taxation turn into high, every further rising in taxation increases the
hamper of it more and more. Indivdual under go greater scarifies for each additional unit of
taxation. The best policy of the government is to balance either sides of fiscal operations by
comparing “the burden of tax” and “the benefits of public expenditure”. The State should balance
the social burden of taxation and social benefits of Public expenditure so as to own maximum
social advantage.

Realization of maximum social advantage requires that;

a)Both public consumption and taxation should be carried dole out up to certain limits and no
more.
b)Public expenditure should be utilized among the varied in an optimum manner, and
c)The various sources of taxation should be so tapped that the combination scarifies entailed is
the minimum.

Assumptions of the Principle

The public revenue consists of only taxes (and not of gifts, loans, fees etc.) and therefore the state
has no balance or deficit budgets. Public expenditure is subject topic to diminishing marginal
social benefits and the taxes are topic to increasing marginal cost or disutility.

As stated to Dalton, maximum social advantage is at some extent where the Marginal Social
Sacrifice (MSS) of taxation and Marginal Social Benefit (MSB) are equal. The point purpose of
equality between MSS and MSB is mentioned because the point of maximum social advantage
or least aggregate social sacrifice. Musgrave calls Dalton’s principle as “Maximum Welfare
Principle of Budget Determination.” He puts that the excellent size of the budget is resolved at
point where Net Social Benefit (NSB) of fiscal operations to the society becomes zero.
The NSB is the diversity between MSB and MSS. (NSB=MSB-MSS). Musgrave conferred
Dalton’s principle of MSA with few minor differences.

As stated of Dalton “Public expenditure in every direction, should be carried just so far that the
advantage to the society of an extra small increase in any direction is commonly counter balanced
by the detriment of a reciprocal increase in taxation or in receipts from other source of public
income. This offers the perfect public expenditure and income”.

CATEGORIES OF GOODS

PUBLIC GOODS The indivisible goods, whose benefits can not be priced, and thus, to which
the principle of exclusion doesn't apply are called public goods. The utilization of such goods by
one person doesn't reduce their availability to other persons.

For instance, the national defense.

Characteristics of Public goods

1)Non-rival in consumption: - One individual’s consumption doesn't decline the amount

convenient to others. Once produced, public goods are convenient to all in equal amount.
Marginal cost of contingent upon the public goods to additional consumers is ZERO.

2)Non-excludable:- Before a public good is produced, the suppliers cannot easily deny it to
people who fail to pay. That is, those that cannot (or don't agree to) pay its market value don't
seem to be debarred or excluded from its use.

3)Free-rider problem: - Individual can savor the advantages of public goods even if they pay for
them or not, they're usually unwilling to pay for public goods. This act is called free-rider
problem.

PRIVATE GOODS
Private goods cite to all those goods and services consumed by private individuals to satisfy their
wants.

For instance, food, clothing, car etc.

FEATURES

1)Excludable: - The suppliers of private goods can very well bare together ignore to those who
are unwilling to pay.
2)Rivalry in consumption: - One individuals consumption cut down the amount applicable to
others. That is, the amount absorb by one person is unavailable for others to consume.

3)Revealed Preference: - The customers admit their preferences through adequate demand and
market price. These divulged preferences are the signals for the producers to produce the goods
the peoples want.

Market demand for private goods is attained by horizontal summation of people demand curves
and that of a public good is attained by vertical summation of people demand curves.

MIXED GOODS
Mixed goods are those goods having benefits which are wholly internalized (rival) and others,
the advantages of which are perfectly externalized (non-rival). The price of manufacturing such
goods partly covered by private contributions and somewhat by government subsidy.

MERIT GOODS Those goods whose expenditure and use are to be encouraged are called merit
goods (e.g.; education) and goods whose expenditure and use are to be discouraged are called
non-merit goods or demerit goods (e.g., liquor, narcotic etc.) drugs Merit goods are culturally
desirable goods which advocate social welfare.

CATEGORIES OF GOODS

Merit goods are rival and excludable. Governments provide merit goods so as to make
distributional justice. These are goods which governments perceive if people will under consume
or produce and thus should be subsidized or provided free. As an Examples of merit goods are
education, mid-day meals in schools, essential food articles etc.This concept was introduced by
Prof.R.A.Musgrave in 1959.

CATEGORIES OF GOODS

CHARACTERISTICS RIVAL NON-RIVAL

EXCLUDABLE PRIVATE GOODS QUASI-PUBLIC

⚫ CAR ⚫ CABLE TV
⚫ PIZZA ⚫ UNCROWDED
⚫ FOOD SWIMMING POOL
NON-EXCLUDABLE OPEN ACCESS PUBLIC GOODS

⚫ OCEAN FISH ⚫ NATIONAL DEFENCE

⚫ MIGRATORY BIRDS ⚫ STREET LIGHT

Merit goods are rival and excludable. Administration bring merit goods in order to provide
distributional justice. These are goods which governments administration perceive if people will
 under consume or produce and therefore should be contribute or provided free. As an examples
of merit goods are education, mid-day meals in schools, essential food articles etc.This theory
was popularized by Prof.R.A.Musgrave in 1959.

References and Supplementary Materials

Books and Journals
1. Hyman David,Public Finance 11th Edition;Pampanga, Philippines
Online Supplementary Reading Materials
www.investopedia.com
www. Study.com
www.accountingtools.com
Citation:
TY - BOOK
AU - Thapa, Ishwor
PY - 2020/07/13
T1 - Public Finance: Concept, Definition and Importance for Country's
Development
DO - 10.13140/RG.2.2.25473.48481